Balance of Trade

The balance of trade (BOT) is defined as the difference between the value of exports and the value of imports of a country. The figure that is derived shows how economically stable a nation is. It is one of the significant components of any economy's current asset as it measures a country's net income earned on global investments.

The existing account also takes into consideration all payments across country borders. Essentially, the trade balance is easy to measure as all goods and services pass through the customs office and are thus recorded.

• Balance of trade refers to the difference in value between the country's imports and exports of goods and services over time.
• A trade surplus or deficit is not always an economy's health final indicator. One must consider it along with the business cycle and other economic indicators.
• A trade deficit is a more favorable trade balance depending on the country's business cycle stage.
• Some countries are opposed to trading deficits. They adopt mercantilism to control them.

The balance of trade is one of the significant components for any economy's current asset as it measures a country's net income earned on global investments.

An economy with a trade surplus lends money to deficit countries, whereas an economy with a large trade deficit borrows money to pay for its goods and services. In addition, in some cases, the trade balance may correlate to a country's political and economic stability, reflecting the amount of foreign investment. Therefore, most nations view this as a favorable trade balance.

When exports are less than imports, it is known as a trade deficit. Countries usually regard this as an unfavorable trade balance. However, there are instances when a surplus or favorable trade balance is not in the country's best interests. For a balance of trade examples, an emerging market, in general, should import to invest in its infrastructure.

Common debit items include foreign aid, imports, domestic spending abroad, and domestic investments abroad. In contrast, credit items include foreign spending in the domestic economy, exports, and foreign investment in the domestic economy.

As briefly stated above, there are two types of balance of trade – favorable/positive trade balance or trade surplus, and unfavorable/negative trade balance or trade deficit.

Favorable/Positive Trade Balance

The balance of trade is positive and favorable when an economy’s exports are more than its imports. Most countries work to create policies that encourage a trade surplus in the long term. They consider surplus a favorable trade balance because it makes a country profit. In addition, nations prefer to sell more products when compared to buying products that receive more capital for their residents, which translates into a higher standard of living. It is also beneficial for their companies to gain a competitive advantage in expertise by producing exports. That results in more employment as companies employ more workers and generate more income.

But in certain conditions, a trade deficit is a more favorable balance of trade, depending on the stage of the business cycle the country is currently in.

• Let us take another balance of trade example – Hong Kong, in general, always has a trade deficit. But it is perceived as positive since many of its imports are raw materials which convert into finished goods and finally exports. That gives it a competitive advantage in manufacturing and finance and creates a higher standard of living for its people.

• Another balance of trade example is Canada, whose small trade deficit results from economic growth. As a result, its residents enjoy a better lifestyle afforded only by diverse imports.

Unfavorable/ NegativeTrade Balance

This is the situation that arises when a country imports more than it exports. Also termed as trade deficits, such situations lead to an unfavorable trade balance for a country. As a criterion, geographies with trade deficits export only raw materials and import many consumer products. Domestic businesses of such countries do not gain experience with the time needed to make value-added products in the long run as they are the main raw material exporter. Thus, the economies of such countries become dependent on global commodity prices.

Some countries are so opposed to trading deficits that they adopt mercantilism to control them. That is considered an extreme form of economic nationalism that removes the trade deficit in every situation.

It advocates protectionist measures such as import quotas and tariffs. Although these measures may reduce the deficit in the short run, they raise consumer prices. Along with this, such actions trigger reactionary protectionism from other trade partners.

The balance of trade formula is as follows:

Balance of Trade = Country’s Exports – Country’s Imports.

For example, suppose the USA imported $1.8 trillion in 2016 but exported $1.2 trillion to other countries. Then, the USA had a trade balance of -$600 billion, or a $600 billion trade deficit.

$1.8 trillion in imports – $1.2 trillion in exports = $600 billion trade deficit

Let us consider the example to see how to calculate the balance of trade figures:

The US has had a trade deficit since 1976, whereas China has had a trade surplus since 1995.

source: tradingeconomics.com

A trade surplus or deficit is not always a final indicator of an economy's health. It must be considered along with the business cycle and other economic indicators. For example, for the balance of trade examples in economic growth, countries prefer to import more to promote price competition, limiting inflation. Conversely, in a recession, governments export more to create economic jobs and demand.

To understand the balance of trade definition more clearly, it is important to know how it enables analysts to learn if an economy is advancing towards growth and progress. Here are a few points to show how it proves to be helpful:

• The balance of trade and the balance of payment are interrelated as the former helps in calculating the latter. The difference between the balance of trade and the balance of payment is that the first one is the difference between a country’s exports and imports figures, while another derives the figure to show how much a country owes to another country and how much is owed to it,
• To maintain the balance of trade, countries dive into international trade, which boosts the foreign trade sector, and leads to the development of better trade policies.
• It plays a great role in maintaining the Gross Domestic Product (GDP) of a country.
• It encourages foreign exchange reserves as international trade gets a significant boost.

This article is a Guide to what is Balance of Trade. Here we explain the concept with a formula with examples, types, and importance. You may learn more about macroeconomics from the following articles: -

• GDP vs GNP - Differences
• Balance of Trade vs Balance of Payments
• Fixed Income Trader
• What is Trade Deficit?